Turkey rate hike stirs Black Wednesday memories

WilliamL. Watts

NEW YORK (MarketWatch) — Don’t take it too far, but the failure of Turkey’s stunning rate hike to provide lasting support for the Turkish lira is stirring memories of the currency crisis that made billionaire George Soros a household name more than two decades ago.

In September 1992, the Bank of England, which was then under the direct control of the U.K. government, hiked its official interest rate from 10% to 12% and then to 15% in a single, chaotic day as it attempted to maintain the British pound’s membership in the exchange rate mechanism, or ERM. For the U.K., the ERM effectively amounted to a pledge to keep its currency at an exchange rate of more than 2.7 deutsche marks to the pound.

Everett Collection

Then-U.K. Chancellor of the Exchequer Norman Lamont at a news conference on Black Wednesday, Sept. 16, 1992. That’s a young David Cameron, a Lamont aide and the current U.K. prime minister, looking on in the background.

Traders saw the hikes for the desperate measures they were, unjustified by Britain’s underlying economic fundamentals. They continued to sell the pound, eventually forcing the government to give up the fight and return the official interest rate to 10%.

The pound fell sharply and Britain dropped out of the ERM, leaving Prime Minister John Major’s government thoroughly humiliated. Soros, who had placed huge bets against the pound, was said to have made around $1 billion in the episode and became forever known as the man “who broke the Bank of England.”

The lira, which had plunged more than 11% versus the dollar since the beginning of January, quickly rallied. But gains were fleeting. The lira is back under pressure, with the dollar buying 2.2394 lira
USDTRY, +0.1557%
in recent action, up from 2.1755 in the aftermath of the rate hike.

It is easy to see why Turkey’s current problems are stirring memories of Black Wednesday. As was the case then, the rate hike was inspired by a desire to support the currency rather than by economic fundamentals. And it is clear that traders are happy to question the credibility of the Turkish central bank.

Turkey’s central bank now finds itself in a “game of chicken” similar to that faced by the U.K. in 1992, said Jane Foley, senior currency strategist at Rabobank in London. Clearly, Turkey’s central bankers had hoped that such a massive rate hike would enhance credibility and keep lira sellers at bay. One would have to assume they are “very disappointed,” Foley said.

Still, while there are elements of Turkey’s predicament that rhyme with the Black Wednesday debacle, the comparisons only take you so far.

“I really don’t see any parallels at all,” said Steve Barrow, London-based currency and fixed-income strategist at Standard Bank. The British government was attempting to maintain the pound in a semi-fixed exchange rate mechanism; the Turkish central bank isn’t, he notes.

Also, the ERM was reeling from the shock created by German reunification. It isn’t clear that a similar shock is impacting Turkey at the moment, he said.

Simon Smith, chief economist at FxPro, sees some parallels, but argues that they are “not that strong.”

During the pound crisis, U.K. interest rates were set by the government. Now we’re in an era of central bank independence, Smith noted. Turkish Prime Minister Recep Tayyip Erdogan had gone on record in opposition to a rate hike ahead of the decision.

That should provide at least some comfort that the decision wasn’t a political one, Smith said.

Turkey isn’t the only country that has been raising rates in an effort to ease pressure on its currency despite less-than-robust economic fundamentals. India previously raised rates and South Africa on Wednesday morning also delivered a hike.

Bloomberg

Will Turkey crisis create the next George Soros?

“The most vulnerable currencies right now are those reliant on overseas capital, which are seen being tested by the gradual withdrawal of U.S. QE and Turkey is one of these, with a current-account deficit of over 7% of GDP. At the time, the U.K.’s deficit was modest at just over 1.5% of GDP,” Smith said.

In the end, though, it is probably a safe bet that Turkish central bankers are feeling some of the same emotions that British policy makers felt in 1992.

If the Turkish central bank “does more to protect the currency, the risk is it would blow up in their face,” Foley said.

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